When it comes to structuring the proceeds of a transaction and managing the wealth created by selling your business or completing a dividend recapitalization, the earlier you begin planning, the better.
How a transaction is organized can have a significant impact on the after-tax wealth generated for you as the owner. It is important to work with an advisor who has experience helping owners structure transactions in a way that limits the proceeds’ exposure to income taxes and eventually estate taxes.
Personal Financial Planning for Business Owners—Frequently Asked Questions (FAQs)
Well before a transaction closes and the funds are received, you should begin working with your wealth advisor to think through the following questions.
- How does my business structure affect my overall planning (or) a future liquidity event?
It is a good idea to consider personal planning considerations around a liquidity event well in advance—even when you are initially establishing your business structure. The right business formation for you may be a C-Corp or an S-Corp. For example, a C-Corp (in which the owners or shareholders are taxed separately from the entity) may allow for the ownership of Qualified Small Business (QSB) stock. Among other benefits, with QSB stock, you may be eligible to eliminate tax on all or a large portion of your gain when you sell—up to 10x cost basis points or $10 million. In the case of an S-Corp (this structure passes corporate income, losses, deductions, and credits through to shareholders for federal tax purposes), you can benefit from a 338(H)(10) election. A 338(H)(10) is a tax election that re-characterizes a stock purchase as an asset purchase. This allows for asset depreciation and other benefits. It is important to engage your wealth advisor to help you understand and make decisions about how business structure can have a meaningful impact on your personal wealth planning. - What are my goals and priorities for selling my business?
For most business owners, a sale or dividend recapitalization will elevate them to a new level of liquid or financial wealth and open a wide array of new possibilities. Before developing a plan for personal wealth management, you should identify what your priorities are and what you would most like to achieve in light of these new opportunities. - How can I avoid capital gains tax on a business sale?
The character of the income from a transaction will have a significant impact on the overall tax exposure for you as a business owner. The top federal long-term capital gains rate is 20% plus potential exposure to a 3.8% tax on investment income. In contrast, the top federal rate for ordinary income is 37%. In most cases, rolled equity can be shielded from tax at the time of the transaction and may qualify for long-term capital gain treatment when realized. It is also important to understand elements of a purchase agreement that affect the ultimate value and the timing of the liquidity, including carried interests, performance-based options, vesting, and earn-outs. - Do my estate planning documents need to be updated before a liquidity event?
A liquidity event often creates opportunities to pass wealth on to younger generations, so you should work with your wealth advisors to evaluate whether the current estate plan will adequately handle the new wealth created by the transaction. Depending on your goals, and your overall wealth, it may be advantageous to establish trusts to shift portions of your equity well in advance of a transaction. - What will my cash-flow needs be after the transaction?
You can work with your wealth advisor to develop a comprehensive financial plan that addresses any large one-time purchases that you as an owner would like to make. You may also want to replace income that you would have previously earned from your business. Your wealth advisor can recreate a “paycheck” from a portion of the after-tax proceeds. The plan also needs to take into account the potential value of any equity rollovers and earn-outs. - What are smart ways to transfer wealth?
If you are looking to transfer wealth to younger generations and believe that the company will sell for more than its current valuation, you may want to transfer shares to a trust for children or grandchildren well before the agreement is finalized. Taking advantage of the pre-transaction valuation discount effectively increases the amount that can be passed to younger generations without being subject to gift or estate tax. You may also consider a GRAT, a grantor retained annuity trust, which minimizes taxes on large financial gifts to family members. Be sure to work with your William Blair wealth advisor to plan well in advance of selling your business, so you can reap the benefits of these and other planning strategies. - How do I avoid assignment of income issues?
Being proactive in implementing wealth-transfer or charitable strategies can help avoid running afoul of assignment of income principles that, if violated, could cause you as the owner to pay income tax on the contributed shares. - How can I achieve the most strategic approach to philanthropy?
Sale proceeds can be used to fund charitable vehicles, such as donor-advised funds, private foundations, charitable trusts, or outright gifts of stock, that generate a tax deduction for the donor. There may also be an opportunity to establish charitable vehicles ahead of a business sale or transaction that can avoid or reduce exposure to capital gains tax. Accelerating the donations into the year of the sale can help offset the taxable income generated by the sale of the company.